November 2

"Stretching Firm and Brand Reputation"

Luis Cabral

Abstract    A firm's quality reputation reflects the track record of the products it sells.  Reputation is an important asset as it influences the consumers' willingness to pay.  When and to what extent shold a firm use this asset to  sell additional products under the same name?  I analyze the different trade-offs of "reputation stretching'' in a formal adverse-selection model of optimal firm strategy and rational consumer behavior.    I characterize three effects: the direct reputation effect (high-reputation firms are paid more for a new product); the feed-back reputation effect (high-quality firms are more likely to strengthen their reputation by adding a new product to their portfolio); and the signalling effect (in equilibrium, launching a new product signals high quality to consumers). Together, these three effects imply that a firm's propensity to stretch its reputation is increasing in its level of reputation and in its quality level.